D2 Exam Questions

Question 1

Explain 3 objectives of a business case that could be used as the criteria to judge its success (25)

Jul 2015

Answer 1

Explain 3 objectives of a business case that could be used as the criteria to judge its success (25)

1. Fostering strategic business focused thinking requiring people with authority to recommend projects/propsals to pre-evaluate their value, rosk or priority
2. Improve efficiency and quality of decision making by weeding out the proposals that cannot demonstrate business value
3. Enable management to evaluate proposals for feasibility, suitability and acceptability
4. Enable management to compare alternatives and options on objective cost/benefit criteria
5. Establish measurement yardsticks by which the subsequent performance, deliverables or outcomes of projects can be evaluated at key review points.

Question 2

Outline the different approaches to the purchase of production materials and capital items (20)

Mar 2013

Answer 2

Outline the different approaches to the purchase of production materials and capital items (20)

Production Materials

1. Items are often bought on repetitive basis, possibly against forecasted demand and linked to a computersied stock management system such as MRP, ERP or SAP system. Repetitition allows for buyer/supplier relationships, purchasing systems and cost reduction programmes to be developed or instigated
2. Purchasing inevitably plays a key role in the acquisition of such items including supplier selection, price, negotiation and contract formation and supplier relationship management
3. Application of the operational objectives of the 5 rights of purchasing applies particularly to production materials
4. Expenditure might be segmented using tools such as Krajlic and different purchasing strategies developed depending on criticality of the items/supply side risk and/or impact on final price. Purchasing has significant influence over such activities.

Capital Expenditure

1. Unlike operational items which entails purchasing’s day to day involvement, capital items are bought far less frequently and are bought for what they can do rather than part of the end product
2. A key distinction lies in the originator of the purchase decision and the decision making. Often production/technical staff will determine the need for specification and in many instances initiate the acquisition by eg requesting prices, undertaking product trials and tests and so on
3. Purchase decisions are more likely to be made on machine (technical) attributes rather than commercial aspects. This does not mean purchasing is excluded from the purchase process but rather they play a difference role for example
   
   • ​​Lifecycle/Whole life costs
   • Countring the possible prejudice of users
   • Provision of commercial, contractual and negotiation expertise
   • Identification of alternatives to outright purchase
   • Identification of grants
   • Assisting with the disposal of the displaced asset

Question 3

Outline the diferences between production materials and capital items (5)

Mar 2013

Answer 3

Outline the diferences between production materials and capital items (5)

Capital items have a long usage life as they are fixed assets used to make the product (ie vehicles, machinery, computer systems, etc) but production materials are part of the actual end product (ie raw materials, components, assemblies, etc).

Capital items are financed/chargeable to a capital account whereas production materials are financed from the revenue budget

When purchasing capital items it is initiated by production/technical staff and purchasing play a supportive role as opposed to production materials that are mainly purchased by purchasing and is concerned with the 5 rights

Question 4

Describe 5 activities a procurement function might undertake when contributing to the development of a business case for a new purchase (15)

May 2014, Jan 2017

Answer 4

1. SYSTEMATIC PURCHASING RESEARCH

Looks at factors that affect purchasing of goods/services to ensure company’s competitive position by securing current and future requirements

Tools:

DEMAND ANALYSIS:

Accurately forecast demand for high value, high usage, high risk materials to minimise sourcing, inventory wastes and risks

VENDOR ANALYSIS:

Evaluate capability of potential suppliers and performance of current suppliers to optimise supplier value and minimise supplier risk

SUPPLY MARKET ANALYSIS:

Appraising conditions in supply market relating to factors such as likely availability and the risk of shortages/disruptions to supply, market prices, price fluctuations, etc.

2. PROACTIVE VALUE ENGINEERING: Value analysis applied at design, development and specification stage of product development to eliminate wastes, over specification and non-value adding features
3. PROMOTE EARLY BUYER INVOLVEMENT: To ensure commercial and supply marketing considerations are taken into account at an early stage when they can make the greatest whole life impact
4. PROMOTE EARLY SUPPLIER INVOLVEMENT: To ensure that solutions take into account supply market expertise, technology and innovation
5. DEVELOP SPECIFICATIONS, SUPPLIER PERFORMANCE MEASURES AND CONTRACT TERMS which will maximise business benefits and value to the buying organisation

Question 5

Explain the characteristics of

1) New Purchase
2) Straight Re-Buy

(10)

Jul 2017

Answer 5

Explain the characteristics of 1) New Purchase 2) Straight Re-Buy (10)

1) NEW PURCHASE

• The item has never been purchased before
• If high value, strategic or high risk item, may be subject to systematic purchasing processes
• Writing a specification of requirements is a good opportunity to build in business benefits of the product, service or project at development stage
• A new purchase will be likely to require a new specification and the need to undertake market research and purchasing research. This may include demand analysis, supplier analysis, supply market analysis, value analysis, early buyer involvement (EBI), and early supplier involvement (ESI).

2) STRAIGHT RE-BUY

• A ‘Straight Re-buy’ is a purchase of something (goods or services) that has already been purchased in the past, to exactly the same specification, once, or more often than once.
• There may already be a pre-existing supply chain, and/or existing preferred supplier(s); pre-existing specifications; and pre-existing market knowledge.
• A business case may have already been undertaken in the past; and the processes for making the ‘re-buy’ will probably be well understood already.
• The procurement activity around a straight re-buy will therefore be more straightforward than for a new purchase. The activity may include review of stockholding and replenishment methods, and investigating options for ‘pull’ or demand-led ordering, such as JIT (‘just in time’) methods, the review of EOQ (‘economic order quantities’), the review of existing specifications, and the review of supply market changes.
• Procurement may also sometimes review the existing long-term contracts, to ensure that the existing suppliers remain competitive; and look to gain additional business benefits from repeat orders and/or renewed contracts.

Question 6

Describe 3 elements to be included in a formal business case to justify a significant expenditure (15)

Jul 2017

Answer 6

Describe 3 elements to be included in a formal business case to justify a significant expenditure (15)

1. Value Proposition

• Clearly state the desired business outcomes or deliverables
• It should indicate the possible business benefits of the outcome in monetary terms.
• Possibly include
  
  • cost estimates
  • financial modelling and ROI calculations
  • risks of the project incl proejct risks, business risks, risks of benefots not realised

2. Scope

• The problem or solution scope
• Assumptions and constraints
• Options identified and evaluated
• Assessment of scale and complexity

3. Work Planning

• Approach
• Project Stage definitions
• Workload estimate or breakdown
• Sourcing or project plans and schedules
• Critical path analysis

Question 7

1

Using an example to illustrate, explain the term budget (5)

Nov-17, Jan-16, May-15, Nov-13

Answer 7

Using an example to illustrate, explain the term budget (5)

A budget is defined as a plan quantified in monetary terms,

prepared and approved prior to a defined period of time,

usually showing planned or estimated income to be generated

and/or expenditure to be incurred during that period

and the capital to be employed to attain a given objective

Question 8

Describe 2 approaches to budgetting used to etablish procurement targets (8)

Nov-17, Jan-16, May-15, Nov-13

Answer 8

Describe 2 approaches to budgetting used to etablish procurement targets (8)

1. Incremental Budget
   
   • Looks at the actual figures from the previous period
   • It is then adjusted in line with known changes to arrive at a budget for the current period
   • For example might add a percentage to the last period’s procurement costs to reflect average cost rises or pricing trends in the supply market
2. Zero based budget
   
   • The previous periods are ignore and it is started completely from scratch
   • For example we might estimate costs and prices for the procurements planned in the new period

Question 9

Explain 3 purposes of preparing a budget for a procurement function (12)

Nov-17, Jan-16, May-15, Nov-13

Answer 9

Explain 3 purposes of preparing a budget for a procurement function (12)

1. To coordinate operations from various departments’ budgets ie sales, engineering, operations, inventory and procurement eg multifunctional projects and processes
2. To control procurement activities and costs by highlighting areas where business benefits may be at risk owing to unexpected costs or unmanaged costs or cost levels, triggering corrective action
3. To pre-authorise estimated levels of expenditure for procurement activities which can thereafter be controlled mainly via ‘reporting by exception’ in the event of a variance

Question 10

Define the term “total lifecycle costing” (5)

Mar-14, Mar-15, Nov-16

Answer 10

Define the term “total lifecycle costing” (5)

Also called Whole Life Costing or Through Life costing can be defined as ‘economic assessment’

considering all agreed projected significant and relevant cost flows

over a period of analysis

expressed in monetary value.

The projected costs are those needed to achieve defined levels of performance,

including reliability, safety and availability.

Question 11

Describe 5 costs that should be considered when calculating the lifecycle cost of an item, apart from the purchase price of the item (20)

Mar-14, Mar-15, Nov-16

Answer 11

Describe 5 costs that should be considered when calculating the lifecycle cost of an item, apart from the purchase price of the item (20)

1. Various transaction costs eg taxes, foreign exchange rate costs and the cost of drawing up contracts
2. Operating costs eg labour, consumables, materials, cost of change, for instance, a decision to use alternative materials
3. Costs of quality ie inspections, re-work or rejection, lost sales, compensation of customers, etc
4. Costs of storage and other handling, assembly or finishing required
5. End of life costs such as decommissioning, removal for sale and safe disposal, re-instatement of land or buildings for alternative use

Question 12

Using examples to illustrate, explain the difference between a straight re-buy and a modified rebuy (10)

May-14, Jan-17

Answer 12

Using examples to illustrate, explain the difference between a straight re-buy and a modified rebuy (10)

A straight re-buy has been sourced from a supplier before and when it is purchased again the specification remains the same, no changes are ever specified. For example we purchase pvc cards with our company logo pre-printed on it a few times a year to print ID cards in house. When we notice stock getting low, we simply issue a purchase order to the supplier who then sends us the pre-printed cards. If we wanted to change the design of the card for example to reduce the logo size, it will become a modified re-buy due to the change in specification. I will have to go back to the supplier, find out if they can indeed make the changes I require, get a quote and then issue a Purchase order for the goods. If this product was a high value and or high spec item, like a computer or a machine, I would have to justify the modification and put it through a systematic procurement process but small value items dont require that.

Question 13

2

Describe the role of a specification at 3 different stages within the procurement cycle (9)

Nov 2017, Nov 2015

LO2

Answer 13

Describe the role of a specification at 3 different stages within the procurement cycle (9)

DEFINE THE NEED

• Define the requirement in a manner that is clear, concise and unambiguous
• Communcating with key internal stakeholders to ensure necessary contribution and buy-in

INVITE QUOTATIONS/TENDER

• Communicating with potential suppliers so that they understand what is required and can produce a credible bid

CONTRACT/SUPPLIER MANAGEMENT

• Measure whether the supplier is conforming against the agreed specification
• Provide evidence of good or poor performance by the supplier, including evidence of what was agreed in the event of a dispute with the supplier

Question 14

Assess four potential consequences of drafting a poor specification for a contract (16)

Nov-17, Nov-15

Answer 14

Assess four potential consequences of drafting a poor specification for a contract (16)

1. Possible misunderstandings with the supplier ie if specification was vague, inaccurate or overly technical this could lead to rejection of deliveries, lost production time, legal disputes and damaged relationships
2. Misunderstanding with other stakeholders over requirements and expectations that dont meet the user’s needs. This could lead to internal conflict, resistance to use the product and loss of credibility to purchasing
3. Likely to be defects in goods supplied that will be costly ie lost time, scrapped goods, additional inspections and controls. If defects reach the customer it could result in lost customer loyalty, lost business and affecting brand reputation
4. Even if the materials and services conform to specification they may fail to function as they should (or to meet the business need) the risk and cost of such a failure is borne by the buyer

Question 15

Outline 5 content sections that might be included in a technical specification (10)

Mar 2016

Answer 15

Outline 5 content sections that might be included in a technical specification (10)

1. Scope of the specification ie its objectives and content
2. Definitions ie explanations of any technical or specialised terms used
3. References to any related documentation ie standards or legislation
4. Desired appearance, texture and finish requirements incl any identification marks, operating symbols, safety instructions
5. Drawings, samples or models of the required product where available

Question 16

Explain 5 disadvantages of using a brand name in a specification (15)

Mar 2016

Answer 16

Explain 5 disadvantages of using a brand name in a specification (15)

1. Brand names are expensive because of high quality, reliability, well known name and image
2. There may be restricted choice of branded products in a market, and perhaps only on esupplier of a given product
3. The supplier may alter specification of its product without changing the branding or notifying customers: ordering by brand may ot therefore conform to the requirement
4. Branded products may be ‘fakes’ (product of low quality passed off under the brand name) and generic products claimed as identical equivalents to a branded products (common in pharmaceutical industry). This may be a particular hazard in consumer purchases.
5. Manufacturers may tend to assume without proper testing, that branded materials or components will be satisfactory but cutting corners on quality assuance is always a risk.

Question 17

Describe 3 circumstances in which a conformance based specification could be used (15)

Jan-16, May-14

Answer 17

Describe 3 circumstances in which a conformance based specification could be used (15)

1. Technical or design specification to meet specific weight, dimensions or tolerance levels that are critical for functional or operational performance. The item must conform to a specification such a drawings, design or blueprint. Typically used in engineering, construction or acrhitectural industries that require a high degree of technical accuracy and very low tolerances
2. Composition Specification specifying chemical or physical make-up of materials or contents. Appropriate in the manufacture of chemicals, manufactured materials ie plastic/metal alloys. May be particularly important where tain physical properties (ie strength,flexibility, durability) are important for safety and/or performance ie in the case of metal used in car manufacture
3. Market Grade Specification - some materials, especially commodities ie steel/wool are subject to a grading system in which qualities such as strength and flexibility are standardised. Buyers are familiar with what each grade implies and purchase according to this grade.

Question 18

Explain 1 possible advantage and 1 possible disadvantage of involving suppliers in producing a specification (10)

Jan-16, May-14

Answer 18

Explain 1 possible advantage and 1 possible disadvantage of involving suppliers in producing a specification (10)

1. Advantage
   
   • The supplier is able to provide expert technical advice in terms of material specifications, tolerances, technological advances, potential changes, etc
2. Disadvantage
   
   • The product may be designed around the suppliers’ capabilities which may be limiting and may lock the buyer into a supplier relationship however If the supplier becomes complacent and no longer provides a quality product it could be problematic

Question 19

Explain the reasons for using standards within specifications (9)

Jul-17, Jul-14

Answer 19

Explain the reasons for using standards within specifications (9)

1. Convenient way to specify quality, safety and performance levels, parameters and tolerances
2. Raise its performance to comply with quality and/or environmental management standards, both to enhance its own quality performance and to demonstrate capability by seeking accreditation or certification under recognised quality schemes
3. Require or encourage suppliers to comply with quality management standards, to support and demonstrate the quality performance of its supply chain.

Question 20

Describe 4 typical KPI’s and outline how they might be used to measure performance in a contract (16)

Jul-17, Jul-14

Answer 20

Describe 4 typical KPI’s and outline how they might be used to measure performance in a contract (16)

1. Quality Management
   
   • Systems and processes are clear and documented
   • Use quality systems because:
   • Convenient way to specify quality, safety and performance levels, parameters and tolerances

Raise its performance to comply with quality and/or environmental management standards, both to enhance its own quality performance and to demonstrate capability by seeking accreditation or certification under recognised quality schemes

Require or encourage suppliers to comply with quality management standards, to support and demonstrate the quality performance of its supply chain.

2. Cost Management
   
   • Consumable purchasing rates are benchmarked for value for money
3. Timeliness
   
   • Service is delivered within the agreed period
   • time of delivery, the lead time, time slots availability and acceptable delay for a delivery.
4. Compliance
   
   • Corporate policies and procedures are adhered to

Question 21

Explain 5 reasons why a buyer might favour an output specification over a conformance specification (25)

March 2013

Answer 21

Explain 5 reasons why a buyer might favour an output specification over a conformance specification (25)

1. Performance specifications are easier and cheaper to draft, compared to more details, prescriptive (conformance) approach
2. The efficacy of the specification does not depend on the technical knowledge of the buyer, suppliers may well know better than the buyer what is required and how it can best be manufactured.
3. Suppliers can use their full expertise, technologies and innovative capacity to develop optimum lowest-cost solutions
4. A greater share of specification risk is borne by the supplier: if the part supplied does not perform its function, or a process or service does nto achieve its target outcome, the buyer is entitled to redress (whereas, with a conformance specification, the specifier bears responsibility for the functionality of the finished result)
5. The potential supply base is wider than with a conformance specification. If the task is to supply a product/service that will perform a particular function or achieve a given outcome, the expertise of different suppliers could potentially provide a wide range of solutions.

Question 22

Explain 5 types of pricing agreements that may be used in contractual agreements (25)

Nov 2017, May 2014

LO3

Answer 22

Explain 5 types of pricing agreements that may be used in contractual agreements (25)

Cost-plus arrangements

The buyer agrees to reimburse the supplier for all allowable, allocable and reasonable costs incurred in performing the contract plus a fixed fee or percentage representing the suppliers profit i.e.

Cost Plus Fixed Fee (CPFF)

• Payment of allowed costs + pre-determined fixed amount as fee for doing the work
• Terms will specify a best estimate and/or capped cost and the amount of the fixed fee, which will change only if the scope of the contract changes (regardless of cost outcome)
• The buyer should calcuate the effect on total price of higher than estimated costs (ie costs + fixed fee for a range of final cost totals), in order to anticipate total liability
• This type of arrangement contains no incentive for the supplier to manage costs, so it is used chiefly for highly uncertain contracts with few options (such as R & D contracts)

Cost Plus Incentive Fee (CPIF).

• Includes payment of allowed costs and higher fee for meeting/exceeding performance or cost target KPI’s
• Used where the cost risk suggests the need for a cost type arrangement but the suppler can be incentivised to reduce costs ie initial production run of new product

Cost Plus Award Fee (CPAF)

• Includes payment of allowed costs plus a fee (bonus) based on contractor’s performance
• Preferred option for services (cleaning, design or software development)
• Ability to reward the supplier for non-quantitative aspects of its performance on a subjective basis.
• An award sum is set aside for the periodic payment of the supplier for ‘the application of effort in meeting the buyer’s needs ie on the basis of the buyer’s subjective evaluation of the supplier’s effort and customer service

1) Fixed Price arrangements

A fixed price agreement is a firm agreement to pay a specified price when the items (services) specificed by the contract have been delivered or accepted

Once agreed (on the basis of negotiation or competitive bidding) the price remains fixed for the duration of the contract

We have a fixed pricing arrangement for our supplier who does all our company’s cleaning, hygiene services and pest control. Specific tasks at specific sites have a fixed price, any work work that falls outside of that scope requires a quote and a PO.

2) Incentive Price arrangements

A fixed price arrangement may provide for adjustment of the final price to include various supplier incentives ie additional bonus payments, profit allowances or value gain sharing for the supplier to shorten lead time or deliver on time, improve quality or technical performance.

The final price will usually b e subject to a pre-negotiated ‘cap’ or maximum price to avoid open ended liability.

Options:

Fixed price incentive (or incentived/gainshare) contracts

This arrangement may provide for adjustment of the final price to include various supplier incentives

Fixed price with review or re-determination clauses

Fixed price arrangements may also allow

Lump sum;
Firm price;

Question 23

Explain two examples of model forms of contract that could be used for a major project (10)

Mar 2016

Answer 23

Explain two examples of model forms of contract that could be used for a major project (10)

The best known examples are:

1. NEC3 (National Engineering Council Version three) suite of model form contracts
   
   • The NEC3 suite of contracts is suitable for procuring a diverse range of works, services and supply projects, spanning major framework deals through to minor works and the purchasing of goods and services
   • Developed in 1990s aiming to introduce a non-adversarial contract strategy to enhance smooth management of contracts
   • They are clear, simple and written in plain English
     using language and a structure which is straightforward and easily understood
2. FIDIC, issued by the International Federation of Consulting Engineers
   
   • Developed a range of contracts that is used worldwide
     
     • Dredgers Contract;
     • Short Form of Contract;
     • Construction Contract;
     • Plant & DB Contract;
     • DBO Contract; and
     • EPC/Turnkey Contract
3. JCT contracts from The Joint Contracts Tribunal

Question 24

Outline the purpose and main content of the following types of contractual clauses:

i. Sub-contracting clause
ii. Insurance Clause
iii. Exclusions Clause

Mar 2016

LO3

Answer 24

Outline the purpose and main content of the following types of contractual clauses:

i. Sub-contracting clause

• A subcontracting clause will explain if, and, if so, how any of the work of the supplier may be sub-contracted.
• Subcontracting may be expressly forbidden; or
• may be allowed without any conditions; or
• may be allowed under certain conditions typically only with the expressed permission, to be sought in advance, of the buyer.
• Subcontracting clauses may also require some contractual requirements such as payment terms, are cascaded down through to subcontractors

ii. Insurance Clause

• Insurance clauses usually require a supplier to effect insurance to cover situations that may arise as a result of the contract;
• such as employer’s liability, public liability, professional indemnity and product liability

iii. Exclusions Clause

• Exclusion clauses are intended to exclude and/or limit some potential liabilities and responsibilities. There are rules and regulations applicable to such clauses and these may also be explained
• Must be constructed concisely and clearly ie the party relying on the clause must prove that properly construed, it relates directly to the loss or damage suffered by the other party

Question 25

Outline FIVE express terms that might be used by a supplier in a commercial agreement for the supply of goods or services (15)

Jan 2016

(LO3)

Answer 25

Outline FIVE express terms that might be used by a supplier in a commercial agreement for the supply of goods or services (15)

1. Time of performance
   
   • Express stipulation of a time performance are usually treated as conditions eg if delivered late then the buyer won’t pay or if the timeframes with regard to the delivery milestones are not met the supplier could be penalised
   • When the contract doesnt specify any time of performance they must be performed within a reasonable time
2. Force Majeure
   
   • Purpose of Force Majeure is to release parties from liability in circumstances where their failure to perform a contract results from circumstances which were unforeseeable for which they are not responsible and they couldn’t have avoided or overcome
3. Sub-contracting clause
   
   • A subcontracting clause will explain if, and, if so, how any of the work of the supplier may be sub-contracted.
   • Subcontracting may be expressly forbidden; or
   • may be allowed without any conditions; or
   • may be allowed under certain conditions typically only with the expressed permission, to be sought in advance, of the buyer.
   • Subcontracting clauses may also require some contractual requirements such as payment terms, are cascaded down through to subcontractors
4. Insurance Clause
   
   • Insurance clauses usually require a supplier to effect insurance to cover situations that may arise as a result of the contract;
   • such as employer’s liability, public liability, professional indemnity and product liability
5. Exclusions Clause
   
   • Exclusion clauses are intended to exclude and/or limit some potential liabilities and responsibilities. There are rules and regulations applicable to such clauses and these may also be explained
   • Must be constructed concisely and clearly ie the party relying on the clause must prove that properly construed, it relates directly to the loss or damage suffered by the other party

Question 26

Explain what is meant by an indemnity clause and provide an example of how such a clause may be used (10)

Jul 2017, Jul 2014

Answer 26

Explain what is meant by an indemnity clause and provide an example of how such a clause may be used (10)

Indemnity clauses are designed to secure an undertaking from one party that it will accept liability for any loss arising from events in performance of the contract. It might include costs or debts, loss or damage to buyer’s property, business losses incurred by the supplier’s poor professional advice, injury to buyer’s staff/customers.

Example:
If there is a leak to the building and the warranty is breached the Contractor is required to rectify any defect and/or pay any damages to the Principal, often on the basis of an indemnity.

Question 27

Describe, with an example, the following price arrangements in commercial agreements: (9)

1) Fixed Price arrangements

2) Incentive Price arrangements

3) Cost-plus arrangements

Nov 2014, Nov 2015

LO3

Answer 27

Describe, with an example, the following price arrangements in commercial agreements: (9)

1) Fixed Price arrangements

• A fixed price agreement is a firm agreement to pay a specified price when the items (services) specificed by the contract have been delivered or accepted
• Once agreed (on the basis of negotiation or competitive bidding) the price remains fixed for the duration of the contract
• We have a fixed pricing arrangement for our supplier who does all our company’s cleaning, hygiene services and pest control. Specific tasks at specific sites have a fixed price, any work work that falls outside of that scope requires a quote and a PO.

2) Incentive Price arrangements

• A fixed price arrangement may provide for adjustment of the final price to include various supplier incentives ie additional bonus payments, profit allowances or value gain sharing for the supplier to shorten lead time or deliver on time, improve quality or technical performance.
• The final price will usually b e subject to a pre-negotiated ‘cap’ or maximum price to avoid open ended liability

3) Cost-plus arrangements

• The buyer agrees to reimburse the supplier for all allowable, allocable and reasonable costs incurred in performing the contract plus a fixed fee or percentage representing the suppliers profit ie
• Cost Plus Fixed Fee (CPFF)
  
  • Paymen tof allowed costs + pre-determined fixed amount
  • Contains no incentive for supplier to manage costs
  • Used mainly for R & D Contracts
• Cost Plus Incentive Fee (CPIF).
  
  • Includes payment of allowed costs and higher fee for meeting/exceeding performance or cost target KPI’s
  • Used where the cost risk suggests the need for a cost type arrangement but hte suppler can be incentivised to reduce costs ie initial production run of new product
• Cost Plus Award Fee (CPAF)
  
  • Includes payment of allowed costs plus a fee (bonus) based on contractor’s performance
  • Preferred option for services (cleaning, design or software development)
  • Ability to reward the supplier for non-quantitative aspects of its performance on a subjective basis.

Question 28

Explain two advantages of a fixed price purchase arrangement for a purchasing organisation (8)

Nov-14, Nov-15

Answer 28

Explain two advantages of a fixed price purchase arrangement for a purchasing organisation (8)

1. Financial risk, since its total price commitment is known in advance and the supplier bears all the risk of cost fluctuations
2. Supplier motivation ie a fixed fee schedules gives the supplier a strong incentive to complete the work efficiently and on time, since any cost saving (below the agreed price) are kept by the supplier and it is liable for any cost blowouts i.e. the supplier’s profit depends on the actual cost outcome - without a minimum or maximimum profit limitation.

Question 29

Explain 2 elements that may cause price fluctuations in a cost plus purchasing arrangement (8)

Nov-14, Nov-15

Answer 29

Explain 2 elements that may cause price fluctuations in a cost plus purchasing arrangement (8)

1. Financial Risk because its total price commitment is not known in advance and it bears all the risk of cost blowouts, exchange rate fluctuations and other factors
2. Administration and contract management costs - supplier’s cost schedules will have to be carefully scrutinised by the cross functional teams (incl financial and management accountants and relevant specialists ie engineers and project planners) and monitored throughout the life of the project to ensure accurate accounting and reimbursement

Question 30

Discuss two examples of standard “Model Form Contracts” (10)

MAR 2013

Answer 30

Discuss two examples of standard “Model Form Contracts” (10)

Model Form contracts are published by third party experts (ie trade associations and professional bodies) incorporating standard practice in contracting for specific purposes within specific industries to ensure fair balance of contractual rights and responsibilities fo buyer and supplier.

NEC3 (National Engineering Council Version three) suite of model form contracts

• intended for use for Civil Engineering, building and electrical or mechanical works
• Developed in 1990s aiming to introduce a non-adversarial contract strategy to enhance smooth management of contracts

FIDIC, issued by the International Federation of Consulting Engineers (represents the global engineering industry)

Developed a range of contracts for construction industry worldwide incl

• The Contruction Contract (Red Book)
• The Plan and Design-Build Contract
• The Short Form of Contract (Green Book)
• The Design-Build Operate (DBO) Contract

Question 31

Explain THREE potential advantages of using ‘Model Form Contracts’ (15)

MAR 2013

Answer 31

Explain THREE potential advantages of using ‘Model Form Contracts’ (15)

1. Helps reduce time and costs of contract development (including legal services costs)
2. Avoids ‘reinventing the wheel’ but can be adapted to suit particular circumstances
3. Industry model forms are widely accepted reducing negotiation time and costs

Question 32

Explain TWO reasons why a ‘fixed price’ contractual arrangement might not be acceptable to a supplier (10)

JAN 2017

Answer 32

Explain TWO reasons why a ‘fixed price’ contractual arrangement might not be acceptable to a supplier (10)

1. If market forces cause the value of the goods or services to increase dramatically, the buyer receives a benefit but the supplier loses potential profits
2. This contract requires a lot of management to ensure that the agreed upon scope is adhered to to minimise ambiguities and then to ensure out of scope work is not done under this contract unnecessartily costing the supplier money

Question 33

Outline FOUR reasons for using ‘model form contracts’ (such as those produced by NEC, FIDIC, and IMechE/IEE), rather than using bespoke contracts (16)

NOV 2016

Answer 33

Outline FOUR reasons for using ‘model form contracts’ (such as those produced by NEC, FIDIC, and IMechE/IEE), rather than using bespoke contracts (16)

1. Helps reduce time and costs of contract development (including legal services costs)
2. Avoids ‘reinventing the wheel’ but can be adapted to suit particular circumstances
3. Industry model forms are widely accepted reducing negotiation time and costs
4. It is fair to all parties

Question 34

Suggest conditions that may be included in a contract to ensure a supplier complies with recognised ethical and labour standards. (10)

May 2016

LO3

Answer 34

Suggest conditions that may be included in a contract to ensure a supplier complies with recognised ethical and labour standards. (10)

1. Adherence to Fair-trade rules
2. Bans on the use of child labour; stringent health and safety requirements
3. Enforcing the payment of minimum wage or fair wage
4. Rules against bribery and corruption; prompt payment of sub-contractors and employees
5. Compliance with CSR policies
6. Enforcement of equality and diversity policies
7. Compliance with International Labour Organisation (ILO) or similar standards
8. Membership of the Ethical Trading Initiative (ETI) or similar bodies
9. Commitment to transparency
10. Commitment to Trades Union recognition.

Question 35

Describe THREE aspects that should be addressed in a contract clause

dealing with sub-contracting (9)

Nov 2016

Answer 35

Describe THREE aspects that should be addressed in a contract clause

dealing with sub-contracting (9)

A subcontracting clause will explain if, and, if so, how any of the work of the supplier may be sub-contracted.

Subcontracting may be expressly forbidden; or

may be allowed without any conditions; or

may be allowed under certain conditions typically only with the expressed permission, to be sought in advance, of the buyer.

Subcontracting clauses may also require some contractual requirements such as payment terms, are cascaded down through to subcontractors

Question 36

Describe FIVE risks for an organisation of outsourcing a strategic function, such as Information Technology management (25)

May 2018, Jul 2016, Mar 2014

Answer 36

Describe FIVE risks for an organisation of outsourcing a strategic function, such as Information Technology management (25)

Question 37

Describe FOUR factors that have contributed to the growth of outsourcing (16)

May 2017, Nov 2017, May 2015

LO4

Answer 37

Describe FOUR factors that have contributed to the growth of outsourcing (16)

1. Quality Drivers:
   
   • increased quality demands,
   • lack of capability to secure quality in the short term, and
   • the potential for outsourcing to ‘bridge the gap’ providing transitional resources and capacity to meet demand
2. Cost drivers:
   
   • the potential of outsourcing to control or decrease costs,
   • supporting competitive advantage (eg on basis of cost leadership)
3. Business focus drivers:
   
   • the use of outsourcing to enable the organisation to focus its effort and resources on primary value-adding and revenue-generating activities (in Porter’s ‘value chain’ model) rather than secondary or support activities
4. Financial drivers:
   
   • the need to free up (limited) capital funds for investment in competitive, value adding business activities
5. Relationship drivers:
   
   • the need to minimise supply chain conflict and divergency of interest, by clarifying responsibility for shared activities, through outsourcing
6. Human resource drivers:
   
   • the need to acquire skills, expertise and experience relatively swiftly, compared to in-house recruitment and development; and possibly also to bypass internal resistance to necessary changes in work processes and structures

Question 38

Outline THREE risks to an organisation of outsourcing a non-core activity (9)

May 2017, Nov 2017, May 2015

LO4

Answer 38

Outline THREE risks to an organisation of outsourcing a non-core activity (9)

1. The organisation failing to distinguish between core and non-core activities and losing its core competence and unique commercial advantages
2. Choosing a poor quality service provider
3. Loss of in house expertise
4. Loss of Control of confidential data and/or intellectual property
5. Unrealistic expectations of the outsourcing project

Question 39

Explain the following express contract provisions, commonly used in outsourcing contracts

a) Confidentiality

b) Indemnities

c) Performance Management

d) Liquidated Damages

e) Dispute Resolution

Mar 2016, May 2014

LO4

Answer 39

Explain the following express contract provisions, commonly used in outsourcing contracts

a) Confidentiality

• confidentiality provisions are designed to potect both parties in situations where they need to give the other party access to information about their operations, especially in an outsourced environment. Confidentiality provisions should define the nature of the confidential information covered, and should make a provision that the other party will take all necessary steps to keep that information confidential, such as Non-Disclosure Agreements

b) Indemnities

• an indemnity provision is designed to secure an undertaking from the outsource provider that it will accept liability for any loss arising from its performance of the contract. An indemnity provision might include costs, such as the reimbursement of any legal costs incurred by the outsourcer as a result of a breach of contract by the outsource provider, loss or damage to the outsourcer’s property, or injuries to staff or customers as a result of the outsourcer provider’s negligence.

c) Performance Management

• A performance management provision is designed to ensure that the outsource provider achieves specific Key Performance Indicators (KPIs) or critical success factors (CSFs); and explains how performance shall be monitored and measured

d) Liquidated Damages

• A liquidated damages clause provides for the payment of a fixed sum of money in consequence of a breach of contract by the outsource provider. The sum of money must be a genuine pre-estimate of the losses.

e) Dispute Resolution

• A dispute resolution provision is designed to determine how any future disputes between the two parties will be settled. In the event of no dispute resolution provision, any dispute would be settled by litigation, which is costly, subject to significant time delays and in the public domain. To avoid this, it is likely that a dispute resolution provision would stipulate that alternative dispute resolution (‘ADR’) or effective dispute resolution (‘EDR’) techniques would be utilised – at least initially. These techniques might include, for example: negotiation, escalation, mediation and/or arbitration.

Question 40

An organisation has decided to outsource two activities: catering and facilities management. (5)

(a) Define the term outsourcing

JAN 2015

LO4

Answer 40

An organisation has decided to outsource two activities: catering and facilities management. (5)

(a) Define the term outsourcing

The strategic contracting out of major non core activities previously carried out inhouse, to an external service provider who are specialists in the particular field.

Potentially on a long term relational basis

Question 41

An organisation has decided to outsource two activities: catering and facilities management. (12)

(b) Describe THREE benefits for the organisation of outsourcing these activities

JAN 2015

Answer 41

An organisation has decided to outsource two activities: catering and facilities management. (12)

(b) Describe THREE benefits for the organisation of outsourcing these activities

1. Allows focussed investment of management, staff and other resources on the organisation’s core activities and competencies (those which are distinctive, value-adding and hard to imitate and thus give competitive advantage)
2. Accesses and leverages the specialist expertise, technology ad resources of contractors - adding more value than the organisation could achieve itself for non-core activities
3. Cost certainty (negotiated contract price) for activities where demand and costs are uncertain or fluctuating - shared financial risks
4. Supports organisational rationalisation and downsizing - reduction in costs of staffing, space and facilities

Question 42

An organisation has decided to outsource two activities: catering and facilities management. (8)

c) Describe TWO disadvantages for the organisation of outsourcing these activities

JAN 2015

Answer 42

An organisation has decided to outsource two activities: catering and facilities management. (8)

c) Describe TWO disadvantages for the organisation of outsourcing these activities

1. Potentially higher costs of services (including contractor profit margin), contracting and management - need to compare with costs of in-house provision and consider potential loss of control
2. Difficulty of ensuring service quality and consistency and corporate social responsibility (environmental and employment practices) - difficulties and costs of monitoring - especially overseas

Question 43

Explain FIVE factors that a manufacturing company will take into account when deciding whether to make a component itself or whether to buy it from a supplier (25)

Jul 2014

Mar 2017

Answer 43

Explain FIVE factors that a manufacturing company will take into account when deciding whether to make a component itself or whether to buy it from a supplier (25)

• Whether the item or activity is strategically important or ‘core’ to the business
• The effects on total costs of production of buying in or incurring costs in-house and whether in-house provision is competitive with external provision
• The availability of in-house competencies and production capacity; how readily they can be acquired or expanded; and whether they will be consistently available in future
• The availability of suitable external suppliers and positive supplier relationships. (a lack of suitable suppliers would push the firm towards the make/do end of the spectrum
• The addressed risks of devolving activities to the external supply chain (eg in terms of loss of control, loss of in-house knowledge and skill, risks to confidential data and intellectual property, etc)
• Human resource impacts. Will a decision to buy out lead to redundancies? Will a decision to make/do in-house lead to a need for training and/or recruitment.
• Potential risks of outsourcing ie loss of expertise and control and poor performance or reputational issues if the supplier fails

Question 44

Explain the meaning of the term /make/do or buy decision’ for goods or services (5)

Nov-14, Nov-15

Answer 44

Explain the meaning of the term /make/do or buy decision’ for goods or services (5)

• A company could make its products in house (possibly buy-in raw materials to make the product) - value added by company
• Or they could minimise their actitivites and buy almost everything from a supplier or subcontractors - value added by suppliers
• Companies will take position somwhere in between these 2 extremes - this is the nature of the make/do or buy decision.
• Where does the company fit into the spectrum?
• Do they make it inhouse?
• Invest in machinery and labour?
• Control the operation internally as a core business activity or do they buy in materials, resources, skills and expertise from outside

Question 45

Outline THREE possible reasons for the failure of an outsourcing contract (10)

MAR 2013

Answer 45

Outline THREE possible reasons for the failure of an outsourcing contract (10)

1. The organisation gradually surrenders control of performance to the contractor which is then able to opportunistically take advantage of the organisation’s dependency
2. The contract does not contain well defined key performance indicators or service levels which means that it is difficult to establish where things are going wrong
3. The organisation has unrealisic expectations of the outsource provider, owing to exaggerated promises and claims in negotiation or underestimation of the risks and costs (and potential for cost escalation)

Question 46

Alternative sourcing options must first be evaluated before making a business case to outsource processes or services. The considerations of these alternative sourcing options may be included as part of the business case.

Q4(a) Describe THREE such alternative sourcing options that could be evaluated when making an outsourcing decision. (15)

MAY 2016

Answer 46

Describe THREE such alternative sourcing options that could be evaluated when making an outsourcing decision. (15)

• Producing the services in-house
• licensing or franchising the technology or designs to external supplier(s)
• establishing a joint development project with another organisation
• acquiring the supplier outright
• purchasing from a qualified external supplier under a normal customer/supplier relationship
• entering into a long term development or supply relationship
• ‘partial outsourcing’ (i.e. giving some elements to an outsourced service provider, but retaining some elements in-house)
• and using a Shared Services Unit to deliver the required services

Question 47

Alternative sourcing options must first be evaluated before making a business case to outsource processes or services. The considerations of these alternative sourcing options may be included as part of the business case.

Q4(b) Discuss TWO options for a purchaser if a contract for outsourced services breaks down (10)

MAY 2016

Answer 47

Discuss TWO options for a purchaser if a contract for outsourced services breaks down

1. establish clearly the underlying problems with the current provider/customer, and implement an action plan for immediate/urgent correction and recovery
2. award the contract instead to another supplier, perhaps the ‘second choice’ provider from the previous sourcing exercise
3. re-tender the contract if too much time has elapsed since the original contract was awarded; or bring the work back in-house

Question 48

Discuss the stages of the procurement process when an organisation outsources an activity. Use examples to illustrate your discussion (25)

Nov 2016

Answer 48

Discuss the stages of the procurement process when an organisation outsources an activity. Use examples to illustrate your discussion (25)

Appraise and pre-qualify suppliers

1. Purpose is to ensure that potential outsource provider will be able to perform the contract to the required standard
2. It avoids risk i(e wasted cost, time and effort) of awarding the contract to a supplier who turns out to lack capacity or technical capability to handle the work, or turns out to have systems and values that are incompatible with the buying organisation and unable to complete the work due to the cashflow​
3. A supplier proposal should cover a wide range of factors that a buyer may consider essential or desirable in its outsour providers.
4. Prequalification criteria should be related to the requirements of the buying organisaion and the service being outsourced.

Contract Negotiation

Contract negotiations may offer the opportunity to:

1. Clarify and fine tune aspects of the provider’s proposal
2. Involve specialist outsourcing expertise in contract development
3. Finalise and agree the terms of the SLA
4. Nominate account, vendor or contract managers and executive sponsors to manage the ongoing contract and relationship

Post Contract Management

1. This is crucial to the success of an outsource contract
2. If the outsource supplier shows signs of struggling to conform with contract requirements, agreed standards of service levels (falling behind schedule or receiving higher than acceptable customer complaints) remedial action may have to be taken ie monitoring and controlling processes more closely
3. Circumstances and requirements will change over the course of the life of a long terms services contract and terms may have to be re-negotiated, agreed and amended accordingly

Question 49

In the context of outsourcing, explain the differences between ‘core’ and

‘non-core’ activities of an organisation (10)

JAN 2017

Answer 49

In the context of outsourcing, explain the differences between ‘core’ and

‘non-core’ activities of an organisation (10)

• Core activities tend to be:
  
  • unique to the organisation;
  • difficult for competitors to emulate;
  • a source of sustainable competitive advantage;
  • enablers of differentiation;
  • enablers of cost-leadership;
  • good barriers to competitors;
  • what the organisation is ‘known for’;
  • key to organisational reputation and - potentially - protected by IPR.
• Non-core activities are usually generic, supporting or enabling activities, and tend also to be those activities that that are also done by very many other organisations - even, by all other organisations.
• These services provide underpinning support to the organisation, but do not in any way distinguish any one organisation from all other organisations.
• Non-core activities tend to be support services, such as: finance; legal; HR; IT support; catering; cleaning; security; printing; repro; research; and - even - procurement.
• Non-core activities may also be those activities through which best value for money can be achieved more clearly by using other providers: those providers that specialise solely in that area, such as specialist IT service providers, and companies that specialise in office cleaning services.
• These specialist providers can gain expertise and economies of scale by making other people’s ‘non-core’ activities into their own ‘core’ activity, and then offering the services for sale on an outsourced basis.
• Thus, non-core activities are more likely to be considered for outsourcing than are core activities; and some would counsel that core activities should never be outsourced, as that risks ‘hollowing out’ the organisation, and destroying its unique selling points.

Question 50

Discuss FIVE possible actions that could be taken to ensure success in outsourcing contracts (15)

MARCH 2013

Answer 50

Discuss FIVE possible actions that could be taken to ensure success in outsourcing contracts (15)

1. Ensure that a proper and full business case is made before considering any of the options. Make sure that the in-house service cannot be improved from its current state
2. Prepare a detailed specification for the service involving those who will be directly in receipt of it
3. Conduct a thorough risk assessment if the process. Make sure the activitiy being outsourced really is non-core
4. Cost the present system carefully based on what is actually achieved. This should be used as a basis for the finacial case to be compared with the outsourcing contracto’s costs on a like for like basis
5. Calculate the payback period but bear in mind that this will involve a lot of estimaion and a few assumptions.

Question 51

Explain THREE aspects of a procurement process for outsourcing that might differ from a process for purchasing goods. (15)

Jan 2017

Answer 51

Explain THREE aspects of a procurement process for outsourcing that might differ from a process for purchasing goods. (15)

Defining the need;

Developing the contract terms;

Sourcing the market;

Supplier appraisal;

Inviting quotations or tenders;

All of these aspects potentially differ when outsourcing and when undertaking a straightforward purchasing of goods. Outsourcing is likely to be a high-spend, strategically significant, long-term, and complex, procurement; and therefore, a procurement process for outsourcing is likely to be one that demands full, formal, processes; and full input from professionals, including procurement professionals, and others. The aspects can therefore be contrasted between those aspects of each stage of the procurement process for outsourcing that might differ if the buyer was merely purchasing goods. Purchases of goods tend to be more frequent and repetitive; perhaps to have lower spend; and to be much easier to specify. These aspects would be reflected in the complexity and time taken for each stage of the procurement process.

Question 52

Explain the purposes of the following clauses in contracts:

(i) Indemnities

(ii) Sub-contracting

(iii) Insurances

(iv) Guarantees

(v) Liquidated damages

MAY 2017

Answer 52

Explain the purposes of the following clauses in contracts:

(i) Indemnity clauses: The purpose of an indemnity clause is to protect the party inserting it against a whole range of liabilities that may arise. Good content also identified some of these circumstances, such as liability for infringement of intellectual property rights, actions by third parties, negligence, or defective products. Good content also explained that the clause allows the party relying on it to recover any losses it has incurred as a result of the other party’s direct or indirect actions.

(ii) Sub-contracting: a sub-contracting clause aims to ensure that contract performance will not be assigned, transferred, or sub-contracted; or will not be without the prior written consent of the buyer. The clause will also set out the requirements of the relationship between contractor and sub-contractor on aspects such as data flow and payment terms. This is designed to ensure that quality control is maintained and accountability is directly with the contractor. Good content also explained ‘privity of contract’.

(iii) Insurances: insurance clauses are sometimes linked to indemnity clauses, and oblige one of the parties (usually the supplier) to maintain insurance policies. The normal insurance requirements are: Employer’s Liability; Public Liability; Professional Indemnity; and Product Liability.

(iv) Guarantees: these clauses typically cover additional guarantees by the supplier that if the goods should fail due to defective workmanship or materials, the supplier will repair or replace the goods. Guarantees usually cover products; but can also cover the level of performance of a service.

(v) Liquidated Damages: Liquidated Damages (‘LDs’) clauses are a pre- determined estimate of losses, and therefore financial compensation to the buyer, for a supplier’s failure to fulfil all or part of the contract. This calculation takes place at the time of forming the contract; and the amount recovered will be the exact amount in the clause, irrespective of the ‘actual’ losses incurred. Some countries require that LDs are solely a genuine attempt to pre-estimate losses should a breach of contract occur, and do not include any ‘punitive’ element.